GODFREY
HODGSON
HOLMES
TARCA
CHAPTER 1
INTRODUCTION
Overview of Accounting Theory
What is a theory?
Hendriksen’s definition:
…the coherent set of hypothetical, conceptual and
pragmatic principles forming the general
framework of reference for a field of inquiry.
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Overview of Accounting Theory
What is an accounting theory?
Hendriksen’s definition:
…logical reasoning in the form of a set of broad
principles that
• provide a general framework of reference by
which accounting practice can be evaluated and
• guide the development of new practices and
procedures.
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Overview of Accounting Theory
• Whether a theory is accepted depends on
how:
– well it explains and predicts reality
– well it is constructed both theoretically and
empirically
– acceptable its implications are
4
Overview of Accounting Theory
•
•
Accounting theory is a modern concept
compared to mathematics or physics
Even Pacioli’s treatise on double-entry
accounting focused on documenting
practice and did not explain the underlying
theoretical basis for it
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Overview of Accounting Theory
The development of accounting
theory has been mostly unstructured
Chambers:
Accounting has frequently been described as a
body of practices which have been developed in
response to practical needs rather than by
deliberate and systematic thinking.
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Overview of Accounting Theory
• Was developed to resolve problems as they
arose – reactive
• Ad hoc approach
• Led to inconsistencies in practice
– e.g. different depreciation methods
• Accounting standard setting
– Conceptual framework projects have not resolved
inconsistency in practice
7
Pre-theory (1400s – 1800)
Goldberg:
No theory of accounting was devised from the time
of Pacioli down to the opening of the nineteenth
century.
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Pragmatic accounting (1800– 1955)
• The ‘general scientific period’
– based on empirical observation of practice
– provided an explanation of accounting practice
– focused on the existing ‘viewpoint’ of accounting
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Normative accounting (1956-1970)
• Sought to establish ‘norms’ for the best
accounting practice
• Focused on what should be (the ideal) v.
what is
10
Normative accounting (1956-1970)
• Degenerated into battles between competing
viewpoints
• Two groups dominated:
– conceptual framework proponents
– critics of historical cost
11
Normative accounting (1956-1970)
• Factors prompting the demise of the
normative period include:
– the unlikelihood of one particular normative
theory being generally accepted
– the application of financial economic principles
– the availability of empirical data and new testing
methods
12
Normative accounting (1956-1970)
• The major criticisms of normative theories
were:
– they do not necessarily involve empirical
hypothesis testing
– they are based on value judgements
13
Positive accounting (1950 to the
present day)
• A shift to a new form of empiricism called
‘positive theory’
• Had its origins in the ‘general scientific period’
• It seeks to explain the accounting practices
being observed
14
Positive accounting (1950 to the
present day)
• Its objective is to explain and predict
accounting practice
e.g. the bonus plan hypothesis
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Positive accounting (1950 to the
present day)
• It helps predict the reactions of ‘players’, such
as shareholders, to the actions of managers
and to reported accounting information
16
Positive accounting (1950 to the
present day)
• Major deficiencies are:
– ‘wealth maximisation’ has become the answer to
explain all accounting practices and reported
information
– it relies excessively on agency theory and dubious
assumptions about the efficiency of markets
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Positive accounting (1950 to the
present day)
• Behavioural research:
– concerned with the sociological implications of
accounting numbers and the associated actions of
‘key players’
– emerged in the 1950s
– despite growing acceptance since the 1980s,
positive accounting theory still dominates
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Recent developments
• Academic and professional developments in
accounting theory have tended to take
different approaches
• Academic research focuses on capital markets,
agency theory and behavioural aspects
• The profession has sought a more normative
approach – what accounting practices should
be adopted
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Recent developments
20
Recent developments
• Conceptual framework – resurrected in 1980s
– states the nature and purpose of financial
reporting
– Establishes criteria for deciding between
alternative accounting practices
– SACs 1–4
21
Recent developments
• Conceptual framework – Recent Developments
– Joint project between IASB & FASB
– International harmonisation of accounting
practices through a single consistent set of
international financial reporting standards (IFRS)
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Recent developments
• The conceptual framework underpinning the
IFRS favours a move toward
– accounting practices that provide information for
enhancing decision making by investors and
others
– recognising all gains and losses in the accounting
periods in which they occur
– measurement using exit values
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Content outline
• Part 1: Accounting theory (chapters 1 – 3)
• Part 2: Theory contributing to practice
(chapters 4 – 10)
• Part 3: Accounting and research (chapters 11 –
14)
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Summary
• Accounting theory
• Major periods of accounting theory
development
• Normative accounting
• Positive accounting
• Conceptual framework
• IFRS
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Key terms and concepts
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Theory
Accounting theory
Normative theory
Positive theory
Behavioural theory
Conceptual framework
IFRS
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